Today Citigroup reported 4th quarter earnings that beat analyst estimates. Profits were about $3.4 billion in the quarter or $1.06 per share. For the full year the company earned $17 billion dollars, or $5.40 per share. Book value and Tangible book value increased to $69.46 and $60.61, respectively. Citi Holdings Assets declined by 43% from the prior year period and now only represent 4% of the balance sheet. These are the most troubled assets that had been the major sources of losses and has reduced overall returns on equity. Citigroup has some of the highest capital ratios in the industry. 4th quarter results, included a net loan loss reserve build of $588MM, largely due to increases for exposure to energy companies. Meanwhile, all of the banks are reporting continued improvement in their legacy residential real estate exposures. Wells Fargo posted very strong results too and its improvement in real estate completely offset the increase in loans for energy. Despite these positive reports, the shares are down with the overall market today.
Many market commentators have been worried about the decline in energy prices and the impact on bank stocks. These worries are dramatically overblown for the big banks’. In yesterday’s earnings call, J.P. Morgan said that if oil prices stayed at $30 for 18 months, the company would only expect to need to add $750MM in additional reserves. That is an astoundingly low number for a company that generates well over $5 billion in net income each quarter. Keep in mind that the $750MM is pretax too. Even better, JPM announced that with just the 25 bps rate hike in December and factoring in no additional hikes in 2016, the company would expect an additional $2 billion in net interest income for the full year. This puts a little perspective on energy exposure, which shows that this market correction for financial particularly is absolutely absurd. Most of the big banks lend to the highest quality companies such as a Royal Dutch Shell, a Chevron, or an Exxon. Also there are government controlled entities that have very strong credit ratings. Most loans are secured and because costs have declined along with revenues, the credit situation in the energy sector is better than people think, although it is clearly distressed. Even when a company goes bankrupt, recoveries to the banks can be quite high. Citigroup is trading at a greater than 25% discount to tangible book value despite posting its best profits in years and with a clear path towards another strong year. This means that the stock would rise by 42% if it just reached current tangible book value. The higher capital ratios will lead to increased stock buybacks, which done at these distressed levels will grow tangible book value at an accelerated rate. The trailing twelve month price to earnings ratio is only 9 and with the reduction in Citi Holdings assets, margins and returns on equity are likely to improve considerably over the next 3 years.
China and now Europe have entered severe bear markets, and almost all markets around the globe including the U.S. are in severe corrections. The Russell 2000 is in a bear market, as are transportation stocks. The real U.S. economy is doing okay though. Consumers have healthy balance sheets as do most corporations. That is very different than 2007-2008. Today is also an options expiration day so volatility is to be expected. Ultimately, things will settle down and value will shine through. Bank of America and Morgan Stanley report next week and I’ll keep you posted on their results but overall the financial sector has never been healthier! We’ve never had the potential upside we have right now in our biggest positions and that is a fact. You’ll know if we are wrong if the banks or insurance companies we are invested in start reporting huge losses this year. That is highly unlikely even in a mild recession. Time and the facts are on our side, which is why we never want to be swayed by volatility and we will always stay calm when others panic. These are the best buying opportunities since we have been in business.